This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, click the "Reprints" link at the top of any article.

How Russia Inc. Moves Billions Offshore

US$51 billion exited Russia in Q1, headed for tax havens. Nations such as the Netherlands, Luxembourg, Cyprus, Switzerland, and Ireland may hold the key to sanctions.

Two years ago, a Dutch law firm prepared a pitch in Moscow to Russian businesses: Come to the Netherlands and we can help you avoid taxes and keep your assets safe.

“You can rely on our legal system!” the firm, Buren van Velzen Guelen, said in a slide presentation.

Such appeals have worked on a grand scale. Russia’s biggest oil, gas, mining, and retail companies—including some run by billionaires close to President Vladimir Putin—have moved tens of billions of corporate assets to the Netherlands and other European countries often used for tax avoidance and capital flight, such as Luxembourg, Cyprus, Switzerland, and Ireland. The firms include OAO Rosneft, OAO Gazprom, OAO Lukoil and Geneva-headquartered Gunvor Group Ltd., which was co-founded by a Putin associate now under U.S. sanctions.

As a result, a handful of European tax havens may hold the key to pressuring Russia to pull back from Ukraine. The extensive use of foreign subsidiaries by Russia’s richest businessmen exposes their assets to sanctions. Yet capitalizing on this vulnerability requires help from countries that rely economically on Russian capital flight and have traditionally protected investors against foreign laws.

“If it can be shown that the owners, through these Dutch structures, are people who are sanctioned, there’s no question that those assets can be frozen,” said Jack Blum, a former U.S. Senate investigator and expert on money laundering and offshore havens. “The question is, ‘How far is anyone willing to go? Are the Swiss and the Dutch and Luxembourg prepared to do that?’ Everybody’s known this has been going on for years.”

The Netherlands, Cyprus, Luxembourg, and Ireland belong to the European Union and must comply with its penalties against Russia. However, they have discretion on whether to pursue tougher, unilateral measures similar to the U.S., which is considered unlikely. Switzerland is not in the EU.

Many European countries have been ambivalent about cracking down on Russia because it supplies much of their oil and gas and is also a significant source of investment in assets such as prime real estate in London. German Chancellor Angela Merkel said May 2 that she’s ready to support sanctions against Russia if it interferes with Ukraine’s May 25 presidential election.

“It’s critical to get on board the banking centers or places where Russians have found avenues or vehicles to invest or nest property,” said Juan Zarate, a former deputy U.S. national security adviser and author of “Treasury’s War: The Unleashing of a New Era of Financial Warfare.”

Volga Sanctioned

The 19 companies sanctioned by the U.S. include Luxembourg-based Volga Group and 10 of its units, according to the U.S. Treasury. Luxembourg had, by a narrow margin, the most foreign direct investment in Russia in 2012 of any country, followed by the Netherlands and Ireland, the most recent full-year Russian central bank data shows.

Those figures likely reflect money returning to Russian investors after having been routed through those countries, said Louise Shelley, director of the terrorism, transnational crime and corruption center at George Mason University in Fairfax, Virginia.

Yet Luxembourg isn’t likely to implement measures that go beyond the EU’s, said E. Wayne Merry, Senior Fellow for Europe and Eurasia at the American Foreign Policy Council in Washington.

“Luxembourg is very good at saying, ‘We’re not giving our approval for things that may have happened somewhere else, but we’re maintaining strict rule of law with what happens within the Grand Duchy,’” Merry said.

In the Netherlands, sanctions have prompted an examination of the country’s role as a popular way station for companies and industrialists routing profits to low-tax jurisdictions like Bermuda and the British Virgin Islands. On May 15, the Dutch Parliament will hold a debate on how Russian and Ukrainian magnates and companies have used the Netherlands to dodge taxes.

Putin has been urging his country’s businessmen for more than a year to bring their capital back home.

“Russian companies have to be registered here, in their home country, and have a transparent ownership structure,” Putin said at a March 20 business conference in Moscow.

Instead, some US$51 billion of Russian capital exited the country in the first quarter of 2014, according to central bank data. That figure has risen to more than US$60 billion, U.K. Foreign Secretary William Hague said last week. A total of US$63 billion flowed out of Russia last year.

U.S. Sanctions

The U.S. has issued four rounds of sanctions against individuals and companies in response to Russia’s seizure of Crimea, Ukraine’s mainly Russian-speaking peninsula that juts into the Black Sea, and its alleged backing of pro-Russian militants who have taken over part of eastern Ukraine. Russian forces, estimated by the North Atlantic Treaty Organization (NATO) to number about 40,000, continue to mass on Ukraine’s border, acting President Oleksandr Turchynov said on April 30.

Last week, the U.S. placed Igor Sechin, the CEO of state-controlled Rosneft, Russia’s largest oil producer, on its sanctions list. His company, which was not put on a blacklist, has billions of dollars in assets in a series of Luxembourg vehicles, records show. The company has also used units in Cyprus, Ireland, Switzerland, and the Netherlands. Its Irish subsidiary reported more than $2 billion in gross revenue in 2012, according to its most recent filing.

Rosneft’s foreign subsidiaries and companies were primarily established by previous owners, a company representative said in an e-mailed statement. These companies are “dormant in Rosneft and are destined for liquidation” once contracts have expired, Rosneft said.

Also under U.S. sanctions is Gennady Timchenko, co-founder of Gunvor, the oil trading company in which the U.S. has alleged Putin has investments. Gunvor, which isn’t under U.S. sanctions, has denied the allegations and said it has never had any links to Putin.

A former Soviet Trade Ministry official, Timchenko met Putin in the 1990s and later sponsored a St. Petersburg judo club where Putin served as honorary president.

After Putin seized control of political opponent Mikhail Khodorkovsky’s Yukos Oil Co. in 2003, many of its most valuable assets ended up in the hands of Rosneft. Rosneft then awarded some trading contracts to Gunvor, helping the company become one of the biggest traders of Russian crude oil. Timchenko has said that his friendship with Putin is overblown and that it hasn’t helped his businesses.

Despite its initial focus on trading Russian oil, most of Gunvor’s sales were routed through a Dutch unit, Gunvor International BV, operating through a branch in Geneva. In 2010, the last time it filed an annual report in the Netherlands, the subsidiary reported $59 billion in revenue, more than 90 percent of Gunvor’s total sales. Thanks to a ruling from Dutch tax authorities, the unit was able to allocate most of its profit to its Swiss branch, helping to cut Gunvor’s global tax bill, disclosures show.

“Gunvor Group is structured for optimal tax planning purposes, the same as other global trading houses,” and “operates in full compliance with all applicable tax laws and regulations,” Seth Pietras, a Gunvor spokesman, said in an e-mail.

Gunvor, which in recent years has slashed its dependence on Russian oil and diversified into trading metals and coal, reported net income of $308 million for last year on revenue of $91 billion.

‘Linked to Putin’

Timchenko, whose net worth is $7.9 billion according to the Bloomberg Billionaires Index, sold his 44 percent stake in Gunvor to his business partner, Swedish national Torbjorn Tornqvist, on March 19, a day before the U.S. imposed sanctions against him. Timchenko owns a residence in Cologny, a wealthy enclave of Geneva.

“Timchenko’s activities in the energy sector have been directly linked to Putin,” the U.S. Treasury Department said in a statement March 20. “Putin has investments in Gunvor and may have access to Gunvor funds.”

Timchenko owns or controls at least 10 companies through his Luxembourg-based Volga Group, the company’s website shows. Stuart Leasor, a Volga Group spokesman, declined to comment.

Gazprom, the state-owned gas company whose CEO Alexey Miller is also considered part of Putin’s inner circle, reported $14 billion of assets in a tiny Dutch unit that employs just 14 people, according to filings. Miller and Gazprom haven’t been placed on any sanctions list.

Gazprom would consider appropriate measures if conditions change, Sergei Kupriyanov, a spokesman for the Moscow-based gas exporter, said by text message, without elaborating.

Ukrainians who are close to Russia have held their assets in tax havens as well. Billionaire Dmitry Firtash made his fortune as a middleman in Gazprom’s secretive gas trade with Ukraine through partial ownership in a Swiss company, RosUkrEnergo. He was arrested in Vienna in March on U.S. bribery charges.

Firtash wrote April 3 on his personal website that the allegations are “completely absurd and unfounded” and he’s confident they will be dismissed.

Frozen Assets

Oleksandr Yanukovych owns a Swiss commodity trading company through a Dutch holding unit. He’s the son of ousted Ukraine president Viktor Yanukovych, who fled to Russia in February. That same month, Swiss police raided and seized documents at the Geneva offices of Oleksandr’s firm as part of an investigation into alleged money laundering. The case is still under investigation and no charges have been filed, according to Swiss authorities.

Viktor Yanukovych and his son have both been sanctioned by the EU. Switzerland has issued a decree freezing all assets Viktor Yanukovych and his entourage might have in Switzerland.

In addition to companies, the U.S. has so far sanctioned 45 individuals, including four it designated as members of Putin’s inner circle: Timchenko, Arkady and Boris Rotenberg, and Yury Kovalchuk.

The sanctions mean that any U.S. assets of those people or companies named are frozen and Americans are generally prohibited from dealing with them. While non-Americans aren’t bound to follow U.S. sanctions, some banks and companies make a point of doing so in order to ensure their access to U.S. markets isn’t compromised.

“Sanctions in some ways give European countries a ‘get-out’ clause,” said Mark Galeotti, a New York University professor and Russian organized crime expert who advises regulators on money laundering. “It allows countries—say, the Netherlands—to say ‘Look, if it was up to us we wouldn’t be putting this pressure on you, but the Americans are beginning to play hardball.’”

While there is some overlap between the European Union’s sanction lists and the one compiled by the U.S., Europe has focused mainly on government officials. It has assembled a blacklist of 70 members, whose assets in Europe are now frozen. They are not permitted to travel within the EU.

Swiss Properties

Switzerland has issued an ordinance that prevents financial intermediaries in Switzerland from entering into new business with the individuals sanctioned by the EU or from transferring any assets to Switzerland from inside or outside the EU. Assets held in Switzerland won’t be frozen, and existing business relationships involving those sanctioned are not subject to the ban.

Economic ties between Switzerland and Russia run deep. About 75 percent of Russian sea-bound crude exports are handled by Swiss-based trading firms including Gunvor, according to the Geneva Trade and Shipping Association, an industry lobby group. Russian energy companies including Rosneft, Gazprom and Lukoil all have trading operations or subsidiary companies in Switzerland.

Swiss banks held 13.8 billion Swiss francs (US$15.7 billion) worth of Russian money in 2012, according to the latest available statistics from the Swiss National Bank. More than a dozen Russian and Ukrainian industrialists have business interests, charity operations, or own property in Switzerland, Tages Anzeiger, a Zurich newspaper reported in March. Andrei Klishas, the politician and metals businessman who was sanctioned by both the EU and the U.S., owns an estate in Ticino, near the Italian border.

Switzerland is “closely” monitoring the situation in Ukraine and the sanctions imposed by its “most important trading partners,” Marie Avet, a spokeswoman for Switzerland’s State Secretariat for Economic Affairs, said in an e-mailed statement.

“Switzerland could take further measures depending on how the situation develops,” she said.

Dutch Reputation

A wide swath of multinational companies, including Google Inc., Yahoo! Inc., and Pfizer Inc., have moved their profits through the Netherlands. It attracts global corporations because of its extensive tax treaty network and lack of withholding taxes on various payments leaving the country for island havens like Bermuda.

The country has promoted these features internationally, including in Ukraine. Last November, the Dutch embassy in Kiev hosted a seminar, whose organizers included international law firm DLA Piper. The event, titled “Dutch holding companies: new opportunities for structuring of Ukrainian business,” included tips on “asset protection structures” and “tax planning opportunities for Ukrainian companies.”

Svitlana Musienko, one of the DLA Piper attorneys who gave the presentation, said the firm had no comment.

An outline of the agenda for the April 17, 2012, presentation by Buren van Velzen Guelen in Moscow cited the various big Russian concerns already using the Netherlands: oil and gas companies Gazprom, Lukoil, and Rosneft; Internet company Yandex NV; X5 Retail Group NV; and mining and precious metals companies Nord Gold NV and OAO GMK Norilsk Nickel.

The firm detailed the particularly generous tax treaty between Russia and the Netherlands, described the virtues of the country’s “flexible” tax policies, and offered examples of several structures to help clients avoid taxes and protect assets, including one that makes it harder to trace a company’s owners.

In one slide, the law firm demonstrated how Russian real estate investors could avoid capital gains taxes on the sale of property there simply by using a Dutch holding company. The firm pointed out that this benefit was not available for investors using vehicles in Cyprus and Switzerland.

“A good reputation is more valuable than a bulging bank safe,” the firm explained, according to another slide.

Peter van Dijk, one of the attorneys at the firm listed on the presentation, declined to comment.

The U.S. sanctions have prompted some Dutch politicians to say they worry about damage to the country’s reputation from hiding the wealth of Russian companies and oligarchs.

“On the one hand we invite them, and make it possible for them to avoid taxes through the Netherlands, while on the other hand we say we freeze the assets, which is a good thing,” said Arnold Merkies, a Dutch parliament member from the Socialist Party. “But why did we allow them in the first place? We even stimulated them to do this.”

“The Netherlands cannot be regarded as a tax haven, and it is not used as such by Russian or any other companies,” said a spokeswoman for the Dutch Finance Ministry. “The Netherlands has been actively involved in the drafting of the recent EU regulations related to the situation in Ukraine and will implement strictly and without delay the provisions thereof, including any necessary measures relating to funds held in the Netherlands.”

The Netherlands “attaches great importance to close coordination between the EU and U.S.” on sanctions, a foreign ministry spokesman said.

Yandex’s decision to domicile in the Netherlands was “motivated solely by corporate law, and not by a desire to optimize our tax structure,” said Vladimir Isaev, a spokesman for Russia’s largest search engine. All of Yandex’s business units “pay taxes on all of their commercial activity in their respective countries.”

‘In a Bind’

The U.S. has given tax havens an excuse for inaction by failing to back up its assertion that Putin is a Gunvor shareholder, said a former senior Treasury official who asked not to be identified because he didn’t want to be seen as criticizing the government’s actions. In addition, some oligarchs may have legitimate reasons for moving funds beyond Putin’s reach, he said.

Countries like the Netherlands and Switzerland are “in a bind, because an awful lot of what they do for a living revolves around structuring and hiding money and assets through very complex structures,” said Blum, the former U.S. Senate investigator. “It really is a tricky question because there is some legitimacy to people putting assets outside of their own country because of political instability. The flip” is that those countries are “also being used by the kleptocrats who are ripping off Russia.”

Treasury & Risk

Treasury & Risk is an online publication and robust website designed to meet the information needs of finance, treasury, and risk management professionals. Our editorial content, delivered through multiple interactive channels, mixes strategic insights from thought leaders with in-depth analysis of best practices, original research projects, and case studies with corporate innovators.